Economics Letters 77 (2002) 195198

www.elsevier.com / locate / econbase

How much should central banks talk?

A new argument
a,b , *
Hans Peter Gruner
a

CEPR, London, UK
University of Mannheim, IZA, Bonn, Germany

Received 17 December 2001; accepted 18 March 2002

Abstract
More openness in central bank decision procedures may increase inflation uncertainty for players on financial
markets when it leads to less wage discipline and higher average inflation.
2002 Elsevier Science B.V. All rights reserved.
Keywords: Central bank transparency; Communication; Inflation uncertainty
JEL classification: E58

1. Introduction
The openness of central bank decision making has recently received new attention in the literature 1 .
It has been argued that more openness reduces uncertainty for players on financial markets and makes
future decisions more transparent (cf. Blinder et al., 2001). In this paper I argue that the opposite may
be the case. The argument is based on a model that studies the interaction of major macroeconomic
players with the central bank.
In the paper I make a distinction between uncertainty about the central banks objectives and
inflation uncertainty. This distinction turns out to be crucial. In the spirit of Cukierman and Meltzer
(1986), I assume that the public is uninformed about the weight which the central bank puts on its
various objectives. The disclosure of information affects the degree of uncertainty about central bank
objectives. However, actual inflation uncertainty is affected by these objectives and by the actions of
all macroeconomic players. In so far as uncertainty about central bank objectives affect trade unions
* Tel.: 149-521-181-1886; fax: 149-621-181-1884.

http: / / www.vwl.uni-mannheim.de (H.P. Gruner).

E-mail addresses: hgruener@rumms.uni-mannheim.de (H.P. Gruner),
1
Recent contributions include Blinder et al. (2001), Cukierman (2001) and Gersbach and Hahn (2001a,b).
0165-1765 / 02 / $ see front matter
PII: S0165-1765( 02 )00125-8

2002 Elsevier Science B.V. All rights reserved.


/ Economics Letters 77 (2002) 195198
H.P. Gruner

196

behavior, it may also have a positive impact both on price stability and on inflation uncertainty. More
uncertainty about future monetary policy objectives leads to more wage discipline, which in turn
lowers average inflation (Sorensen, 1991, derives the same result from a very similar model).
Moreover, I show that the variance of inflation may be reduced as well.

1.1. The model

The model is a two stage game in which a monopoly union interacts with a central bank. Previous
models of this sort can be found in Cukierman and Lippi (1999), Gruener and Hefeker (1999), and
others.
Two variables are determined in this game: The (log of the) nominal wage w and inflation p. The
nominal wage is fixed by the monopoly union before the central bank fixes p. Both variables
determine the (log) real wage W 5 w 2 p and unemployment u 5 a ? W. Without loss of generality I
fix a 5 1.
The objectives of both players are the following. The central bank cares about inflation and
employment. Its utility function is
C(p, u) 5 2 Ip 2 2 u 2 ,

(1)

where I is a measure of the central banks inflation aversion. The union cares about the real wage and
employment. Its objective is to maximize
A
U(w, p ) 5 W 2 ] u 2 .
2

(2)

The parameter A measures the unions aversion to unemployment. The reaction function of the central
bank can be derived as

p 5 b ? w,

(3)

where b 5 1 / 1 1 I. The trade union is not perfectly informed about the central banks preferences
when it fixes w. It knows the mean of the inflation reaction E(b) 5 b and the variance

s 2b 5 E[(b 2 b )2 ].

(4)

Measures that make the decision process more transparent are assumed to result in a reduction of s 2b .

1.2. Equilibrium
Taking into account the central banks expected reaction the union maximizes the following
function at stage 1:

A
E w 2 p 2 ] u2
2

(5)

A
5 E (1 2 b)w 2 ] ((1 2 b)w)2
2

(6)


/ Economics Letters 77 (2002) 195198
H.P. Gruner

A
5 E (1 2 b)w 2 ] (1 2 2b 1 b 2 )w 2 .
2

197

(7)

The solution of this problem is

Es1 2 bd
w 5 ]]]]]]
Ef As1 2 2b 1 b 2dg

(8)

1 2 b
w 5 ]]]]]]]
2
2
As1 2 2b 1 b 1 s bd

(9)

or

1.3. Results
An immediate consequence is Sorensens (1991) result:
Proposition 1. Uncertainty about central bank preferences reduce wages, average inflation and
unemployment.
Proof. Wages decline with s 2b as can be seen from (9). Moreover, according to (3) average inflation
and average unemployment decline as well. Q.E.D.
Next we analyze whether more uncertainty about the central banks preferences necessarily creates
more inflation uncertainty. It is useful to define
2 ] 5 w 2 ? s 2b
s 2p [E[(p 2 p )2 ] 5 E[(bw 2 bw)

(10)

We have
ds 2p
dw 2
2
]]
s
2 5 w 1 2w ]]
ds b
ds 2b b

(11)

1 2 b
5 w 2 2 2ws 2b ]]]]]]]
2
2 2
A(1 2 2b 1 b 1 s b )

(12)

1
5 w 2 2 2w 2 s b2 ]]]]]]
2
2 .

(1 2 2b 1 b 1 s b )

(13)

This derivative is positive iff:

2
2
1 2 2b 1 b . s b
2
2
(1 2 b ) . s b .

Hence we have:

(14)
(15)

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/ Economics Letters 77 (2002) 195198

H.P. Gruner

Proposition 2. Inflation uncertainty increases with uncertainty about central bank preferences when
the latter is low. It decreases when uncertainty about b is high.
Proof. see above.

2. Discussion
The present paper adds another theoretical argument in favor of limited central bank transparency to
the contributions by Sorensen (1991), Cukierman (2001), Cukierman and Meltzer (1986) and
Gersbach and Hahn (2001a). According to Sorenson, uncertainty about central bankers preferences
may lead to more wage discipline. Wage setters act more carefully when they know less about the way
in which the central bank might react to their wage claims. This reduces equilibrium wage claims,
inflation and unemployment on average. Governments that are concerned about inflation and
unemployment should therefore be careful about introducing too much transparency.
I have shown that, even sticking to the narrow objective of low inflation uncertainty, it may not
always be optimal to improve the publics information about the central banks future objectives. This
is the case when there is an upper bound on the degree of informedness of the public. Consider e.g.
the case where new rules for information disclosure can reduce uncertainty to a level s 2b $ s 2b,min . 0.
If this minimum level exceeds s1 2 b d 2 then any reduction of uncertainty about future moves leads to
an increase of inflation uncertainty.

Acknowledgements
The paper was written while I was visiting the economics department at London Business School. I
thank this institution for its hospitality.

References
Blinder, A.S, Goodhart, C.A., Hildebrand, P.M., Lipton, D., Wyplosz, C., 2001. How Do Central Banks Talk? Geneva
Reports on the World Economy 3.
Cukierman, A., 2001. Are Contemporary Central Banks Transparent about Economic Models and Objectives and What
Difference Does it Make?, mimeo.
Cukierman, A., Lippi, F., 1999. Central Bank Independence, Centralization of Wage Bargaining, Inflation and UnemploymentTheory and Evidence European Economic Review.
Cukierman, A., Meltzer, A.H., 1986. A theory of ambiguity. Credibility and inflation under discretion and asymmetric
information. Econometrica 54 (5), 10991128.
Gersbach, H., Hahn, V., 2001a. Should the individual voting records of central bankers be published?, Deutsche Bundesbank,
discussion paper 02.01.
Gersbach, H., Hahn, V., 2001b. Voting transparency and conflicting interests in central bank councils Deutsche Bundesbank,
discussion paper 03.01.
Gruener, H.P., Hefeker, C., 1999. How will EMU affect inflation and unemployment in Europe? Scandinavian Journal of
Economics 101, 3347.
Sorensen, J.R., 1991. Political uncertainty and macroeconomic performance. Economics Letters, 37.